Operating Margin Definition

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What is an operating margin?

The operating margin measures the profit that a company makes on a dollar of turnover, after having paid variable production costs, such as wages and raw materials, but before paying interest or taxes. It is calculated by dividing a company’s operating profit by its net sales.

The operating margin formula is

The

Operating margin=Operating profitReturned begin {aligned} text {Operating margin} = frac { text {Operating profit}} { text {Turnover}} end {aligned}

Operating margin=ReturnedOperating profitTheTheThe

How to calculate the operating margin

When calculating an operating margin, operating profit is the same as EBIT or profit before interest and taxes. The EBIT, or operating profit, is the income less the cost of goods sold and the sales, general and administrative costs of running the business, excluding interest and taxes.

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Calculation of operating margin

What does the operating margin tell you?

The operating margin of a business, also known as return on sales, is a good indicator of the quality of its management and its degree of risk. It shows the proportion of income available to cover non-operating costs, such as interest payments, which is why investors and lenders are paying close attention to it. Highly variable operating margins are a leading indicator of commercial risk. Likewise, looking at a company’s past operating margins is a good way to assess whether a sharp improvement in profits is likely to last.

How to calculate the operating margin

To calculate a company’s operating margin, divide its operating profit by its net sales:

The

Operating profit margin=OI / SRor:OI = Operating profitSR = Turnover begin {aligned} & text {Operating profit margin} = text {OI / SR} \ & textbf {where:} \ & text {OI = Operating profit} \ & text {SR = Sales revenue} \ end {aligned}

TheOperating profit margin=OI / SRor:OI = Operating profitSR = TurnoverTheThe

Operating profit is often called profit before interest and taxes (EBIT). Operating profit or EBIT is the income that remains in the profit and loss account, after deduction of all operating costs and general costs, such as selling costs, administrative costs and cost of goods sold (COGS ):

The

EBIT=Gross revenue(OE + DA)or:OE = Operating expensesDA = depreciation and amortization begin {aligned} & text {EBIT} = text {Gross income} – left ( text {OE + DA} right) \ & textbf {where:} \ & text {OE = En expenditure operation} \ & text {DA = Depreciation and amortization} \ end {aligned}

TheEBIT=Gross revenue(OE + DA)or:OE = Operating expensesDA = depreciation and amortizationTheThe

Operating margin limits

The operating margin should only be used to compare companies that operate in the same industry and ideally have similar business models and annual sales. Companies in different industries with very different business models have very different operating margins, so comparing them would make no sense.

To facilitate the comparison of profitability between companies and industries, many analysts use a profitability ratio which eliminates the effects of financing, accounting and tax policies: profit before interest, taxes, depreciation and amortization (EBITDA). For example, adding depreciation, the operating margins of large manufacturing and heavy industrial enterprises are more comparable.

EBITDA is sometimes used as a proxy for operating cash flow, as it excludes non-cash expenses, such as depreciation. However, EBITDA is not equal to cash flows. Indeed, it does not adjust to any increase in working capital nor does it account for the capital expenditures necessary to support production and maintain the asset base of a business, as do cash flows from exploitation.

Other use for operating margin

Operating margin is sometimes used by managers to see which business projects add the most to the bottom line. However, how to allocate overhead costs can be a complicating factor.

For more information, learn more about the analysis of operating margins.

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